Note: In this project, the Boards have considered two broad approaches to lessor accounting:
Discussion of lessor accounting issues at today's meeting presumes a performance obligation approach, which is the model tentatively agreed to by both Boards.
- Derecognition approach. Under this approach, the lessor is viewed as having transferred a portion or all of the leased asset to the lessee in exchange for a right to receive rental payments. The lessor derecognises the leased asset because it no longer controls the right to use that asset during the lease term. As such, the lessor derecognises the leased asset and recognises a receivable. The lessor continues to recognise those rights that have not been transferred to the lessee (the residual value of the asset).
- Performance obligation approach. Under this approach, the lessor is viewed as having granted the lessee the right to use its economic resource (the leased asset) in exchange for the right to receive rental payments. The lessor does not lose control of the leased property and continues to recognise the leased asset. The lessor would recognise a receivable for the right to receive rental payments and a corresponding liability for the obligation to permit use of the leased asset.
Sale and leaseback transactions
As part of their discussion of whether a sale and leaseback transaction under the performance obligation model should be accounted for as a sale rather than a financing transaction, the Boards were presented with the following two approaches:
- Determine whether the transaction is a sale of the underlying asset. If not, then account for it as a financing transaction.
- Determine whether the leaseback is a lease. If the leaseback represents the repurchase of the underlying asset rather than a lease, it should be accounted for as financing.
Without much discussion, the Boards agreed that the most appropriate test to apply is whether the transaction represents the sale of the underlying asset. Having supported the sales approach, the Boards were then presented with the following two approaches to determine whether a sale has occurred:
- Approach A: Apply the control criteria developed in the revenue recognition project.
- Approach B: Determine whether control has been transferred and all but a trivial amount of the risks and rewards associated with the underlying asset have transferred to the buyer.
Several Board members supported approach B as they are of the opinion that it will ensure that most sale and leaseback transactions are accounted for as financing transactions, which is the substance of most such transactions. Those members also felt that considering the risks and rewards is the only approach consistent with the leasing model and that, when looking at the sale and leaseback transactions in combination, it will give the most appropriate answer. Some supporters of approach B questioned why such a high hurdle ('all but a trivial amount') should be cleared in order to recognise a sale.
Other Board members supported approach A. They questioned why the control criteria developed for the revenue recognition project are not applied to these transactions.
Another Board member did not support including any guidance on how to account for sale and leaseback transactions in the leasing standard as enough guidance have already been developed in other standards. The first test should be to determine whether a sale has occurred by applying the revenue recognition criteria. If the transaction is deemed to be a financing arrangement, then guidance on financial instruments should be applied. Lastly, if the transaction is deemed to be a lease, then the guidance on accounting for leases should be applied.
Following a long discussion on the merits of each approach, the majority of Board members supported approach B, although some members qualified their support for this approach by requesting that the same criteria be applied in the revenue recognition model.
The Boards then deliberated when a gain or loss arising on a sale and leaseback transaction should be deferred by considering two approaches:
- Defer gains or losses on sale and leaseback transactions that are not at fair value.
- Adjust the assets, liabilities, gains, and losses recognised to reflect current market rentals.
The FASB members indicated very strong support for the latter approach but questioned whether it is practicable. The staff responded that this approach is similar to the existing requirements of IAS 17 for sale and leaseback transactions and should therefore not be too difficult to apply in practice. Not all Board members agreed with this response.
One IASB member added another alternative by stating that when a sale and leaseback transaction is not established at fair value, the recognition of a sale, is precluded and the transaction should be accounted for as financing. Several other IASB members indicated sympathy with this alternative, while others favoured the same approach supported by the FASB members.
When put to a vote, Boards unanimously agreed that as long as the sale and leaseback transaction results in a sale and both the sale and leaseback are at fair value, gains or losses arising from the transaction should not be deferred. The majority of Board members also tentatively agreed that where either the sale or the leaseback is not established at fair value, the assets, liabilities, gains, and losses should be adjusted to reflect current market rentals.
Lessor accounting - Accounting for lessor's performance obligation, including consideration of recognising profit/loss at lease commencement
At their November 2009 meeting, the Boards tentatively agreed that the subsequent measurement of the performance obligation should depict the decrease in the entity's obligation to permit the lessee to use the leased item, but requested the staff to clarify how the performance obligation should be regarded as satisfied and revenue recognised. At this meeting, the staff recommended that the revenue should be recognised in a systematic and rational manner as the performance obligation is satisfied. This could be based on time, usage, or other measure that the economic benefit derived from the leased asset is provided to the lessee.
Some Board members questioned how the lessor is supposed to determine the rate of usage by the lessee. Another Board member remarked that this seems to imply that when a lessee is not using a leased asset properly, the lessor has not satisfied its performance obligation and does not get to recognise revenue. Other Board members also disagreed with the proposal as they deemed it inconsistent with the revenue recognition model where revenue is recognised as services are performed or goods transferred, regardless of usage by the customer.
In defence of the staff proposal, a Board member explained that the aim was to allow for a method of revenue recognition that is similar to the unit of production method of depreciation and usage by lessee does not refer to actual usage, but rather to usage agreed to as part of negotiating the contract. Following this explanation, the majority of Board members supported the staff's proposal.
The Boards then considered the following approaches in determining whether a lessor should be required/allowed to recognise a profit/loss at the commencement of the lease:
- Approach A: Recognise profit/loss upon delivery of leased asset to the lessee.
- Approach B: No profit/loss upon delivery of the leased asset to the lessee.
- Approach C: Recognise profit/loss upon delivery of leased asset to lessee but only for some lessors.
Several Board members disagreed with the staff proposal to prohibit the recognition of a profit or loss at lease commencement and noted that it is not consistent with the revenue recognition or performance obligation model. Those Board members were of the opinion that once a performance obligation has been satisfied, revenue should be recognised and that the delivery of the leased asset to the lessee is one of the performance obligations of the lessor.
The Boards deliberated at length whether a lessor has more than one performance obligation. The FASB showed strong support for the staff proposal, but the IASB was split evenly. In the absence of the Chairman to cast a deciding vote, it was agreed that the staff should bring the matter back later in the week.
The staff then asked the Boards which lessors should be allowed to recognise a profit or loss. Again several Board members vehemently disagreed with the staff proposal that any lessor - whether the carrying amount of the underlying asset is different from its fair value - should recognise a profit or loss, as this approach focusses on the amount at which the lessor has recognised the underlying asset. In their view, this approach is consistent with the derecognition model and not the performance obligation model being discussed. Another Board member remarked that under the performance obligation model, the consideration receivable should be allocated to the various performance obligations based on their stand-alone selling prices, similar to the revenue recognition model. Other Board members questioned what the related cost would be for the revenue recognised.
The Boards tentatively agreed that the recognition of revenue on day one should not be limited to only dealer and manufacturer lessors, but that revenue recognised should not be based on the carrying amount of the underlying asset. With regards to how the revenue should be recognised, the Boards instructed the staff to explore the alternatives under the performance obligation model further, along with the earlier question on whether the lessor has more than one performance obligation. As this is likely to take the staff some time to prepare the necessary agenda papers, it was agreed that the matters be discussed at the special meeting in early May.
Accounting for subleases - performance obligation model
The Boards were asked to consider the accounting for subleases under the proposed new leases requirements under the performance obligation approach. Without any discussion, the Boards agreed that special recognition and measurement guidance is not needed for assets and liabilities arising under subleases.
The Boards discussed various alternatives for the presentation of assets and liabilities arising from a sublease. The FASB members preferred an alternative whereby the right-of-use asset, lease receivable, and the performance obligations of the lessor are presented gross with a subtotal as part of property, plant, and equipment in the statement of financial position, with the obligation to make rental payments presented separately as part of the liabilities (alternative C-prime). The IASB members initially expressed a preference to for the gross presentation of all amounts without any subtotals (alternative A).
The staff remarked that this will be totally inconsistent with the previous decision by the Boards with regards to the gross presentation with a subtotal for lessors and questioned whether the IASB is willing to accept the inconsistency and explain their reasoning in the basis for conclusions.
After careful consideration, the IASB members changed their preference to the gross presentation of all assets and liabilities excluding the obligation to pay rentals, with a net subtotal (alternative C). In order to achieve convergence between the Boards, the FASB members indicated that they can also support alternative C instead of C-prime as initially indicated.
The Boards further tentatively agreed to require the disclosure of the nature and amount of material subleases in the lessor's financial statements. The Boards will continue their discussions on lease accounting at later sessions.